LONDON: S&P Global Ratings revised its outlook on U.K.-based bank holding company HSBC Holdings PLC to negative. At the same time, S&P affirmed ‘A’ long-term and ‘A-1’ short-term issuer credit ratings on HSBC Holdings.

“We also revised our outlook on certain core subsidiaries of the HSBC group to negative and affirmed our ‘AA-‘ long-term and ‘A-1+’ short-term issuer credit ratings on these entities. The affected subsidiaries are: HSBC Bank PLC, HSBC UK Bank PLC, HSBC France, HSBC Bank Canada, HSBC Bank USA N.A., and HSBC Securities (USA) Inc. We also revised the outlook on U.S. bank holding company, HSBC USA Inc., to negative and affirmed the ‘A/A-1′ ratings,” S&P said in a press release.

These rating actions have no effect on the other rated HSBC subsidiaries, the resolution counterparty ratings (RCRs) that we assign to certain HSBC subsidiaries, or the rated hybrids.

The outlook revision on HSBC Holdings PLC and certain subsidiaries follows management’s announcement that it will not achieve its 2020 returns target. “We understand that this will result in a further restructuring of the business model. This will be the third iteration of restructuring, following material changes in 2011 and 2015. We acknowledge the difficult operating conditions for HSBC, not least the low interest rate environment for a deposit-heavy institution”.

However, the ongoing changes to its Continental European and U.S. businesses and parts of its Markets business could lead us to re-evaluate our currently favorable view of the diversification and business stability benefits of HSBC’s business model.

HSBC recently announced its results for the first nine months of 2019, with a reported annualized return on tangible equity (RoTE) of 9.5% (albeit at a lower 6.4% in the third quarter of the year). Statutory profit before tax was $17.2 billion, up 3.7% year-over-year. Historically, HSBC’s fourth-quarter earnings have tended to be weaker than in other quarters, in part due to the negative impact of the U.K. bank levy. We note that operating performance in both Hong Kong and the U.K.–-HSBC’s two largest markets–has remained resilient, despite heightened political unrest in Hong Kong and political uncertainty in the U.K. in recent months.

HSBC no longer expects to reach its RoTE target of greater than 11% by 2020. HSBC’s new management team has indicated that it will rebalance capital away from low-return businesses and adjust the cost base accordingly. In particular, management has highlighted the weak returns in its Continental Europe and U.S. businesses–despite previous restructuring efforts in both–and parts of its Markets business. HSBC has stated it expects to maintain its common equity Tier 1 ratio (CET1) above its 14% target, despite expected restructuring charges.

The ratings continue to reflect HSBC’s many relative credit strengths. These include its highly diversified business risk profile and its robust balance sheet. For example, as of Sept. 30, 2019, HSBC stated that its CET1 ratio was 14.3%, despite the completion of a recent $1 billion share buyback.

Furthermore, as of the same date, it had a Stage 3 loans ratio of 1.3%, lower than major U.K. peers’, and its loan-to-deposit ratio was a low 74%. Despite some mishaps over the past dozen years, either stemming from from prior acquisitions, conduct, litigation, or restructuring issues, these credit strengths have not waned.

Indeed, HSBC has never come close to reporting an annual loss, unlike some other large banks. From 2011 to 2018, reported statutory profit before tax ranged between $17 billion and $22 billion, with the exception of 2016 ($7 billion). This partly reflects the strength of its Asia Pacific franchises, which we expect to remain the key driver of earnings growth.

The negative outlook reflects the implementation challenges of the planned restructuring in the context of a weakening external environment. This could lead us to lower the currently high ratings on HSBC versus other global banks. “We are unlikely to take a further rating action upon the announcement of the details of the restructuring. HSBC has stated that this will take place either before or at the same time as its full-year results announcement in February 2020”.

“We could lower the ratings over our two-year outlook horizon if HSBC is unable to demonstrate a clear path to rebuild its statutory earnings and meet stakeholder expectations.

“We could also lower the ratings if our view of the economic prospects in HSBC’s major markets deteriorate and significantly weaken its revenues or asset quality.

“A one-notch lowering of our sovereign rating on the U.K. (AA/Negative/A-1+) would not automatically lead to a rating action on HSBC Holdings or its ‘AA-‘ rated core operating subsidiaries. However, we would assess whether the main factors contributing to such a downgrade also affected our view of economic risks in the U.K. banking sector and our assessment of HSBC’s U.K. exposures.

“A one-notch lowering of the group SACP would lead us to lower our hybrid ratings by one notch. Similarly, a one-notch lowering of the issuer credit ratings would lead us to lower our RCRs on HSBC’s operating companies by one notch.

“We could revise the outlook to stable if the benefits of HSBC’s business and geographic diversity, in conjunction with its robust balance sheet profile, continue to support business stability”.